Spain, Italy and 12 banks of the United Kingdown have been downgraded by ratings agencies, intensifying the financial crisis that is already rattling Europe.
Fitch Ratings has downgraded the Italian Republic's (Italy) foreign and local currency Long-term Issuer Default Ratings (IDRs) from 'AA-' (AA minus) to 'A+' (A plus) and the short-term rating from 'F1+' to 'F1'. The outlook on the long-term ratings is Negative. The Country Ceiling of 'AAA' has also been affirmed.
Prior to Fitch's downgrade, Moody's Investors Service downgraded Italy's government bond ratings to A2 with a negative outlook from Aa2, while affirming its short-term ratings at Prime-1.
Spain's Long-term foreign and local currency Issuer Default Ratings (IDRs) has been downgraded to 'AA-' from 'AA+'. The rating Outlook is Negative. Fitch has simultaneously affirmed Spain's Short-term rating at 'F1+' and the Country Ceiling at 'AAA'.
Weakens Italy's Soverign Risk Profile
The Italian downgrade reflects the intensification of the Euro zone crisis that constitutes a significant financial and economic shock which has weakened Italy's sovereign risk profile.
As Fitch has cautioned previously, a credible and comprehensive solution to the crisis is politically and technically complex and will take time to put in place and to earn the trust of investors. In the meantime, the crisis has adversely impacted financial stability and growth prospects across the region. However, the high level of public debt and fiscal financing requirement along with the low rate of potential growth rendered Italy especially vulnerable to such an external shock.
Italy's sovereign credit profile remains relatively strong and is supported by a budgetary position that compares favourably to several European and high-grade peers. As a sovereign and nation it is solvent. Moreover, as the third largest economy in the euro zone, Italy is a 'core' member of EMU and the rating incorporates Fitch's judgement that, in extremis, the ECB and/or EFSF/IMF will provide support to prevent a self-fulfilling liquidity crisis.
The structural weaknesses that have constrained economic growth are well-known: high public debt and tax burden; an inefficient public sector; barriers to competition in product markets and services; inflexible labour market; and a pronounced "north-south divide".
On a wide-range of economic and fiscal indicators Italy has underlying fundamentals consistent with a high investment-grade rating. Addressing the current crisis of confidence by meeting its fiscal targets and making progress on reforms necessary to enhance potential growth would stabilise the rating, as would resolution of the euro zone crisis.
On the part of Moody's, the main drivers that prompted Italy's rating downgrade are:
(1) The material increase in long-term funding risks for euro area sovereigns with high levels of public debt, such as Italy, as a result of the sustained and non-cyclical erosion of confidence in the wholesale finance environment for euro sovereigns, due to the current sovereign debt crisis.
(2) The increased downside risks to economic growth due to macroeconomic structural weaknesses and a weakening global outlook.
(3) The implementation risks and time needed to achieve the government's fiscal consolidation targets to reverse the adverse trend observed in the public debt, due to economic and political uncertainties.
Risk to Fiscal Consolidation
Spain's downgrade primarily reflects two factors: the intensification of the euro area crisis and secondly, risks to the fiscal consolidation effort arising from the budgetary performance of some regions and downward revision by Fitch of Spain's medium-term growth prospects.
While gross external debt (169% of GDP in 2010) is not high by euro area comparison, the net external debt of the economy (91% of GDP in 2010) is one of the highest in the world, reflecting a relative lack of Spanish foreign financial assets. This leaves the Spanish external finances sensitive to interest rate increases. While the current account adjustment has been significant, falling from 10% of GDP in 2007 to 4.5% of GDP in 2010 and a forecast 3.2% in 2011, further adjustment over the medium is necessary to improve the external balance sheet.
The intensification of the euro area crisis was identified as a negative rating trigger on 4 March 2011 when Spain's rating Outlook was revised to Negative. With large fiscal and external financing needs, heightened volatility has adversely impacted market financing conditions for
Spain as illustrated by the Eurosystem's intervention in the secondary market. However, Spain's 'AA-' rating incorporates Fitch's judgement that as a solvent and systemically important sovereign, in extremis, the ECB and/or EFSF/IMF will provide support to prevent a self-fulfilling liquidity crisis.
The second principal driver of the downgrade of Spain's sovereign ratings is the budgetary performance of some regional governments, which in Fitch's opinion, poses a risk to fiscal consolidation. In September 2011, the agency downgraded five autonomous communities and maintains a Negative Outlook on the sector reflecting the still difficult fiscal and economic environment and the execution risks in implementing some of the cost cutting measures announced.
While the sub-national sector's debt was only 11.1% of GDP in 2010, it accounts for roughly one-third of total expenditure, making it a vital part of the necessary correction in the public finances to restore confidence and public debt sustainability.
Moody's Downgrades 12 UK Banks
Moody's Investors Service has downgraded the senior debt and deposit ratings of 12 UK financial institutions and confirmed the ratings of 1 institution.
The downgrades have been caused by Moody's reassessment of the support environment in the UK which has resulted in the removal of systemic support for 7 smaller institutions and the reduction of systemic support by one to three notches for 5 larger, more systemically important financial institutions.
According to Moody's, announcements made, as well as actions already taken by UK authorities have significantly reduced the predictability of support over the medium to long-term. Moody's believes that the government is likely to continue to provide some level of support to systemically important financial institutions, which continue to incorporate up to three notches of uplift. However, it is more likely now to allow smaller institutions to fail if they become financially troubled. The downgrades do not reflect a deterioration in the financial strength of the banking system or that of the government.
In addition, the rating agency has assigned a negative outlook to the senior debt and deposit ratings of the banks that still incorporate two or more notches of systemic support, to reflect the likelihood of a further reduction in the availability of systemic support over the medium to long term.
The rating actions include a one-notch downgrade of Lloyds TSB Bank plc (to A1 from Aa3), Santander UK plc (to A1 from Aa3), Co-Operative Bank plc (to A3 from A2), a two-notch downgrade of RBS plc (to A2 from Aa3) and Nationwide Building Society (to A2 from Aa3); and downgrades of one to five notches of 7 smaller building societies.
The ratings of Clydesdale Bank were confirmed at A2 (negative outlook). As outlined in the May press release, we have reviewed the standalone ratings of all entities prior to concluding on the debt ratings.
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